IZA DP No. 6051 Extensive and Intensive Margins of Labour Supply: Working Hours in the US, UK and France Richard Blundell Antoine Bozio Guy Laroque October 2011 DISCUSSION PAPER SERIES Forschungsinstitut zur Zukunft der Arbeit Institute for the Study of Labor Extensive and Intensive Margins of Labour Supply: Working Hours in the US, UK and France Richard Blundell University College London, IFS and IZA Antoine Bozio Institute for Fiscal Studies Guy Laroque University College London, IFS, INSEE-CREST and IZA Discussion Paper No. 6051 October 2011 IZA P.O. Box 7240 53072 Bonn Germany Phone: +49-228-3894-0 Fax: +49-228-3894-180 E-mail: [email protected] Any opinions expressed here are those of the author(s) and not those of IZA. Research published in this series may include views on policy, but the institute itself takes no institutional policy positions. 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IZA Discussion Paper No. 6051 October 2011 ABSTRACT Extensive and Intensive Margins of Labour Supply: Working Hours in the US, UK and France* This paper documents the key stylised facts underlying the evolution of labour supply at the extensive and intensive margins in the last forty years in three countries: United-States, United-Kingdom and France. We develop a statistical decomposition that provides bounds on changes at the extensive and intensive margins. This decomposition is also shown to be coherent with the analysis of labour supply elasticities at these margins. We use detailed representative micro-datasets to examine the relative importance of the extensive and intensive margins in explaining the overall changes in total hours worked. JEL Classification: J21, J22 Keywords: labor supply, employment, hours of work Corresponding author: Richard Blundell Department of Economics University College London Gower Street London WC1E 6BT United Kingdom E-mail: [email protected] * We thank the Data archive UK, INSEE and IUPMS for data access. 1 Introduction Forty years ago the French and British used to work more than the Americans. They now work less. The aim of this paper is to provide a coherent picture of these changes. To do so we split the overall level of work activity into the number of individuals in work and the intensity of work supplied by those in work. This reflects the distinction between whether to work and how much to work at the individual level and is referred to, respectively, as the extensive and intensive margin of labour supply. At the aggregate level the former is typically measured by the number of individuals in paid employment and the later by the average number of working hours. The difference between the extensive and intensive margins has been highlighted in recent research attempting to resolve differences between micro and macro responses of labour supply to tax reform. For example, Rogerson & Wallenius (2009), following the work of Prescott (2004), argue that the responsiveness of the extensive margin of labour supply to taxation plays a major role in explaining aggregate differences in total hours worked across countries. They show that an economy with fixed technology costs for firms and an inverted U-shape life-cycle productivity for workers can produce large aggregate extensive labour supply responses driven by movements in employment at either end of the working life. This, they argue, can reconcile the small micro-based elasticities of hours worked with the large responses required if taxes and social security are to explain cross- country differences in total hours of work. The distinction between the extensive and intensive margins has long been recognised in microeconometric studies of labour supply (Heckman 1993). For example, building on the insights by Gronau (1974) and Heckman (1974, 1979), Cogan (1981) documented the importance of fixed costs of work in separating the link between responses at the employment and hours margin. His study found that earlier estimates of hours of work elasticities at the intensive margin for married women were biased upwards due to the omission of fixed costs. In subsequent empirical analyses the size of the wage elasticities at these two margins has been found to differ significantly by gender, family composition and age (Blundell & Macurdy 1999). Typically the elasticity at the extensive margin has been found to be somewhat larger than the elasticity at the intensive margin. Over time, as labour force participation of women increased, the labour supply elasticities of men and women have, to some extent, converged (Blau & Kahn 2007). It is not only women with children where the role of the extensive labour supply margin has been found to play a major role in understanding individual and family labour supply 2 behaviour over the life-cycle. `Early retirement' behaviour has been found to respond systematically to participation tax rates implicit in social security systems, see for example Gruber and Wise (1999) and papers therein. The relative size of labour supply responses at the intensive and extensive margin has also been a key parameter in the public economics literature on earnings tax design, see Diamond (1980), Saez (2002) and Laroque (2005). A `large' extensive elasticity at low earnings can `turn around' the impact of declining social weights implying a higher transfer to low earning workers than those out of work, in turn providing an argument for lower tax rates at low earnings and a role for earned income tax credits. Participation tax rates (PTR) and effective marginal tax rates (EMTR) at low earnings remain very high in many current tax systems. This is carefully documented in the evidence to the Mirrlees Review, see Brewer et al. (2010) and references therein. In the UK effective marginal tax rates are well over 80% for some low income working families because of phasing-out of means-tested benefits and tax credits. A related discussion in labour supply elasticities is the time horizon of behavioural responses. Many micro-based studies have focused on weekly hours of work while macro- based analysis look at aggregate measures of annual hours of work. The measure and properties of the extensive (no work at all vs. some positive work during the period) and intensive (average hours supplied by the workers) margins are sensitive to the length of the reference period. Furthermore, the labour elasticities are different when assessed at the steady state or when they incorporate intertemporal substitution effects (Blundell & Macurdy 1999, Chetty et al. 2011). But what do we know about the importance of these margins for different types of workers? How well does the extensive margin explain changes in total hours over time and across countries? In this paper we provide a detailed decomposition of the evolution of total hours of work into changes at the extensive and intensive margin. We examine three key countries - the US, the UK and France. These three countries stand at the top, middle and bottom, respectively, of Prescott's 2004 table of labour supply flexibility. They are also countries where we can access nationally representative detailed microdata over a long period of time so as to examine the relationship between the extensive and intensive margin across different individual types. We study the forty year period up to 2008. The UK provides an interesting comparison with the polar cases of France and the US. Over this period the UK has adopted many of the same (or similar) tax policies as in the US (Blundell & Hoynes 2004) while, at the same time, it has moved from a dominant position 3 in the supply of total hours to one lying between the US and France. This analysis, which complements the results presented in Blundell, Bozio & Laroque (2011b), finds that neither margin dominates in explaining changes in total hours worked for these countries, rather the relative importance of the extensive and intensive margin is shown to differ systematically by age, gender and family composition. Section 2 provides an overview of the changes in aggregate hours worked over the last forty years. Section 3 presents a theoretical framework to decompose the aggregate labour supply elasticity into extensive and intensive sub-elasticities. It applies a statistical framework providing bounds on the empirical measures of the intensive and extensive margins to the case of France, the UK and the US. Section 4 presents detailed description of the labour margins for some specific demographic groups, i.e. the young, the mothers and the older workers. Section 5 concludes. 2 Working Hours in the US, the UK and France 2.1 Definitions and Data Labour supply is a multi-faceted concept and can cover relatively broad definitions. Our interest is in market work but we shall not equate non-market work with \leisure", as it could include household production and voluntary work. Even if we might like to measure the amount of labour supply accounting for effort and productivity, we concentrate in this paper on a narrower definition of labour, i.e. time spent in market work.